Thursday, July 29, 2010

July 28, 2010 Catch and release, it works with stocks too.


July 28, 2010 Catch and release, it works with stocks too.

I’m back! We had a great time doing death by fishing again this year. Nothing clears the mind more than walking through the majestic rivers and streams of Yellowstone National Park, trying to figure out where the fish are, what kind of bug they are chompin’ on, and how to present your size 18 (That would be about the twice the size of this letter J) Blue Winged Olive fly so said trout will chomp on it. Oh yeah, you do this while trying not to fall in the river and keeping a wary eye out for those pesky Bison and occasional Grizzly Bear.

When we catch a fish, we (collectively we call ourselves The Fishwhisperers) put a little pressure as possible on the fish, release them for other anglers to enjoy or possibly to live another season and catch them exponentially bigger next year.

And so it with is stocks. Our last post suggested you pick up a copy of Katsenelson’s “Active Value Investing” for these directionless volatile markets. It’s main premise is, the days of buy and hold are long gone. Ironically Matt Barthel from Barron’s had a piece this weak explaining that hedge fund managers and especially financial advisors are now recommending active versus passive portfolio management techniques. In the article he describes how high net worth account holder’s understand the need to be more nimble now than ever. Catching and releasing equities is becoming not only acceptable, but effective in drawing returns worthy the big bucks that fund manager take. We suggest the article.

Since leaving for holiday, we have seen the portfolios I am involved recover an average of about 4%. Perhaps I should stop publishing the blog. . . . waiting for the applause to end . . . . However I did take a bit of a hit on GLD the Gold ETF which was one of or stellar performers over the last few months. Our average cost on it is 106.39. We have seen 122 which means we should take some profit if and when it hits 112. At 113 today we have to decide whether to take the cash or wait. The Euro worries seem to have subsided, No One is talking about short term (12-18) month inflation, in fact the "D" word is bantered around a lot more than the "I" word, but WalMart could address deflation with a 2% price increase overnight. So what is gold going to do.

The shiny stuff is up 500% since 2002. But it is still almost half of its 1980 inflation adjusted price of $2,360 an ounce. So if you are into reading tea leaves, there is plenty of room to the upside, however there is no place for interest rates to go but eventually up which should eventually tarnish the commodity even if it is in the next business cycle (Beyond 24 months). Again, an interesting article in Barron’s by Alan Abelson, he takes an anti-Gold Bug view of the nuggets. Abelson quotes Bank Credit Analysts Peter Berezin for his contrarian view. The overall gist is Gold is a sound investment for at least the next 12-18 months, but keep an eye on inflation, interest rates, and the dollar exchange.

And in a further indication I have no life, if you look at the December Calls to Put Option Chart on Schwab, it cost about 15% more to put the GLD ETFs versus calling the ETF indicating a slightly bearish trend. So what will we do? Nothing. I have stop order at 111 and hope it does not trigger. If it does, I’ll take the 6% gain and be happy. Remember, NEVER be ashamed of taking a profit. Keep in mind we have been in and out of this ETF since June 09. If we stop out, we will have a realized annualized gain of about 13.5% before the firm of ORP (Obama, Reid, and Pelozi) has there way with us.

Over the last week, we have been asked to kick the tires on a few stocks and or funds and ETFs. Here is some feedback on some of those.

Bob H. asked if I had seen the Proshares UltraPro Short (or Long) Dow30 ETFs. SDOW and UDOW are the tickers. The goal of these funds is a plus or minus 300% daily leverage of the return of the DOW industrial average. In other words if you are UDOW, Dow Long, for every percentage point up, the ETF should be 3 percentage points up. A 100 point gain on a 10,000 dow would be one point so the long fund should reflect a 3% gain. Ok, how do they do it?

I read the prospectus and even after reading it, I am still confused as to how they, on a daily basis, utilize equities (The Dow 30), derivatives of those equities, futures contracts on those equities, less than a year swaps, money market accounts, and certain none Dow 30 basket securities. In this case, I go to rule number one in my investment rule book. If you don’t know how they make money, don’t buy the stock. (To this day, Warren Buffet only holds 100 shares of his friend’s former company Microsoft, because he does not completely understand the business model-his words)

Don’t get me wrong I find both of these ETFs intriguing, but you really have to feel confident in guessing the market (The DOW) and you would have to tend those ETFs several times a day to protect your down side. This is speculation at its best, and the reader who sent this to me pointed that out in his note. Not for the faint of heart for sure.

There was a few questions from readers and some fringe readers about MSFT. If you go back to the July 11th post, we did some reverse linkage using the positive news about the number of Windows 7 seats to prognosticate the number of Boxes (CPUs) being shipped and as a result suggested Intel would have a hell of a earnings report. They did. We suggested then it was time to get on Board the Balmer Train. We got in on July 13 at 25.13. We have another buy in at 24.75, but it has not triggered. We might be moving that up to 25.25. For the tea leave readers there does seem to be resistance at 26, but as we saw last August-Sep, once it breaks the high end of the trading channel (Think Bollinger Bands here), it made it to about 32. There are fairly priced target prices of 33.50-35 out there by some of the big boys (Barkley’s, Oppenheimer, UBS) They gotta a gaga ROE of 43%. There current P/E is 12.7 and forward looking is 9.79. (BTW, in Barron’s this week a historical study showed that most forward looking estimates are optimistically inaccurate to the tune of about 21%.) Even if that is the case with this stock it forward looking P/E would be 11.8, a bargain. Also check out their Price to Book at 4.9. If you screen the Dow 30 for a P/B value between 3-5, you get the likes of JNJ, CSCO, KO, UTX, MMM, AXP, CAT, and DD. None of them have a forward looking P/E below 10. The second cheapest on the list is Johnson and Johnson at 11.53. In other words we will be adding to our MSFT position.

Then we had a hopefully new reader ask about a company called DryShips, Inc. DRYS, through its subsidiaries, engages in the ownership and operation of drybulk carriers and drilling rigs that operate worldwide. Its drybulk fleet principally carries various drybulk commodities, including bulk items comprising coal, iron ore, and grains; and minor bulk items, such as bauxite, phosphate, fertilizers, and steel products. As of April 6, 2010, the company owned and operated a fleet of 39 drybulk carriers consisting of 7 Capesize, 28 Panamax, 2 Supramax vessels, and 2 Panamax newbuilding vessels with a combined deadweight tonnage of approximately 3.3 million dwt, as well as owned and operated 2 ultra-deep water semi-submersible drilling rigs and 4 ultra deep-water newbuilding drillships. The company was founded in 2004 and is based in Athens, Greece.

The company reported today and blew by estimates of 22 cents a share and scored 30 cents a share income giving it a current P/E of 11.25 and forward looking P/E of 4.45. That makes it look real cheap. Let’s see if we can figure out why. I am working on 3 red wines and a scotch so this could be sketchy. They have had positive free cash flow since sep 08. They currently have 149 million in FCF. That compares to 958 million in long term debt. (This is a capital intensive segment and according to their earnings report today they are taking delivery on 6 new ships which does not help Long Term Debt.) They have reduced LTD 40 % over the last 2 years. They suspended their 20 cent a share dividend first quarter 2009. And they don’t do stock buybacks.

I had to do some homework to find the raw file for their second quarter earnings report as they are regisetered in Athen Greece so they file a 6-K filing not an 8-K filing. To quote the report “The dry cargo freight market was relatively strong in the first half of 2010, with Panamaxes averaging $30,155 per day. In July, dry bulk freight rates have dropped significantly from the level seen earlier in the second quarter as, among other factors, steel mills undergo maintenance and overbuilt steel inventories are run down. DryShips is insulated from this seasonality as our drybulk carriers are almost 100% fixed for remaining 2010 and 82% for 2011. This seasonal slowdown in the market is expected to be short lived as long-term fundamentals of the drybulk market remain strong. If on the other hand this downturn is prolonged we will be poised to take advantage of opportunities that will arise.” That comment reflects some of what we mentioned here on July 12, 2010 and here are those comments, “Today’s WSJ had several gems in it if you looked for them. In the Money and Investment section there was some dismal information about the Baltic Dry Index. I have mentioned that metric many times here in the SL blog. However I may have misrepresented the number as being the tonnage of cargo shipped internationally. It is in fact an indicator of the daily rate charged for shipping. That rate has collapsed over the last two months. It is actually lower than April 2009 figures. So it could be extrapolated that the global economy is no longer expanding. However, and this is not in the article, rates are determined by availability of tanker. During the economic boom of 06-09, when oil was high and commodities were high possibly due to a dismal dollar, shipbuilders went on a frenzy floating anything they could build. That capacity is now on the high seas creating carrier to carrier competition meaning they are lowering their rates. Henceforth, (cool word- always liked that word) rates are falling and the BDI is collapsing. I would for a while pull this metric out of the leading economic indicator crystal ball.”

So you could extrapolate DRYS is cheap for a reason. There are a bunch of ships going on line making that 30,000 a day in shipping fees difficult to sustain unless there is surge in the world economy and dry good, bulk good demands significantly increase.

Also of note in the report is the re-issuance of senior convertible notes to improve their balance sheet. Again this is a very capital intensive industry and the issuance of debt is far from unordinary. It does raise a question in my mind how the debt and interest service will impact free cash flow in Q3 and Q4. You also have to look at the 8.7 million in income for Q2 against the long term debt of 958 million in LTD. That seems to be quite a hole to dig out of. In their best quarter Q2 08 when oil was in the stratosphere and the global economy party was going on full tilt, their income was 299 million. Their average for the last 8 quarters is a minus 68 million a quarter.

Underneath all of this funky fundamental stuff is the fact that the board just replaced the CEO. As you may know that is a huge red flag for us when a CEO or CFO gets an opportunity to “Spend more time with their family.”

Now to be fair, out of 137 companies in the service shipping sector, DRYS is in the top 20 or so depending upon the stat you choose. (That is an indication this is a weak sector). One worth taking a closer look at is VLCCF, Knightsbridge Tankers Limited, through its subsidiaries, engages in the seaborne transportation of crude oil and dry bulk cargoes worldwide. As of December 31, 2009, the company's fleet consisted of four double-hull very large crude oil carriers and two capesize dry bulk carriers. It serves oil companies, tanker companies, dry bulk carriers, petroleum products traders, and government agencies. Knightsbridge Tankers Limited was founded in 1996 and is based in Hamilton, Bermuda. I ran across this one in March doing some homework on the Baltic Dry Index. We liked it as they seem to get a higher price for their services and their margins were a bit better. (36 vs 28 agains DRYS). VLCCF also has a nice yield at 8.31% base upon a Feb dividend of 30 cents and a May throw of 40 cents a share. It seems like the best of breed in this sector, but it is a dog of a sector.

In closing the market today hit some technical restraints and backed off. The real blanket (a heavy and wet blanket I might add) was a piss poor durable goods order. Most were expecting a .4% improvement after a dismal -.8% drop last month, NOT. We got a -1.0% drop. Ouch. Look for the market to start out in the red in the morning. Bob H. maybe a good time to play your SDOW. Do it with your Vegas money baby. I just downladed the July Beigebook report from the Fed to my Kindle to read in bed. What an exciting life I lead!

Salve Lucrum


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